Admiral Products Steer a Course to Lower Fees

The Vanguard Group is lowering the standards for the mutual fund industry--and that’s good news for investors.

Vanguard last week introduced four U.S. Treasury portfolios that apparently are the least-costly mutual funds anywhere. They’re also a notable departure from the general trend toward modestly higher fund expenses.

Vanguard, one of the nation’s largest fund families with $94 billion under management and 4 million customer accounts, says it will charge shareholders just 0.15% a year in total operating costs on its new Admiral Funds--equivalent to $1.50 in combined fees for every $1,000 investment increment.

By contrast, the average Treasury-bond fund charges $7 for each $1,000, the average taxable-bond portfolio $10.80, and the typical stock fund $14.20, according to Morningstar Inc., a Chicago research firm.

Fund fee numbers, which are expressed in a standard measure known as the expense ratio that’s listed in the prospectus, include costs for management, custodian, legal, accounting and various other services. They also include 12b-1 marketing fees, but not sales charges or “loads.”

Vanguard, (800) 662-7447, a no-load giant based in Valley Forge, Pa., can offer the Admiral portfolios for such low cost because it doesn’t tack on a profit margin. Unlike competitors, it’s a corporation owned by the shareholders in its many funds.

By contrast, other groups are either privately held or owned by stockholders who have invested in a management company that offers the funds.

This isn’t to say that Vanguard’s officers don’t draw salaries commensurate with industry standards--they do. But they don’t divvy up profits, since the firm is run with the intention of breaking even.

There are two catches with the new Admiral portfolios, however.

First, you need a minimum of $50,000 to invest in one of the funds--even for individual retirement accounts.

On average, mutual fund accounts cost about $30 a year to maintain, which means smaller customers are proportionately more expensive to keep, says John C. Bogle, Vanguard’s chairman.

By barring smaller shareholders from the Admiral Funds, Vanguard is “taking the starch out of the expense ratio,” Bogle says.

The second limitation is that the Admiral Funds only hold Treasury securities.

One portfolio invests in money-market Treasuries (that is, T-bills), while the others are bond funds of the short-, intermediate- and long-term varieties.

Vanguard doesn’t have any current plans to extend the Admiral concept to other types of investments, although non-Treasury money-market funds might be the next step, Bogle says.

Why do the Admiral products focus on Treasuries? Simply because Treasuries are so homogenous and liquid that Vanguard doesn’t need to spend much to research or trade them.

In addition, bond funds in general return less than stock funds, so any reduction in expenses will tend to have a bigger impact on their bottom lines.

“On the equity side, people are less fee-sensitive,” Bogle admits.

Stated another way, investors appear more tolerant of higher fees on a stock fund that they think has the potential to outperform the market by a wide margin.

Vanguard, which enjoyed a reputation as the low-cost leader even before introducing the Admiral Funds, has tended to produce good results over the years, especially on its bond products.

For example, for the five years ending Oct. 31, the company’s diversified U.S. stock funds rose 14.1% annually on average, the same as diversified stock funds in general, according to information provided by Morningstar.

But the company’s taxable domestic bond portfolios beat the competition, 11% to 9.8%. And among stock-bond “hybrid” funds, Vanguard enjoyed a 12.9% to 10.6% edge.

Marketing costs and similar expenses do not figure in the calculation of a fund’s performance, nor generally is a sales fee included.

In recent years, expenses have been rising modestly for mutual funds as a whole, despite an increase in average portfolio size--a factor that should have resulted in some economies of scale.

According to Morningstar, expense ratios rose from 1.19% to 1.53% for domestic equity funds from 1980 to 1991, from 0.87% to 0.98% for taxable bond funds and from 1.29% to 1.89% for international stock portfolios.

Higher fees can be partly justified by the wider array of services that have become standard in the business--services such as toll-free telephone numbers, dividend-reinvestment programs and no-cost switches between funds.

Bogle, however, counters that the industry has also benefited from computerization, which has lowered record-keeping costs in many cases.

In his view, expense ratios have been creeping higher because of the explosion of 12b-1 plans, the relatively recent introduction of higher-cost new funds and a reluctance by management companies “to share the economies of scale with fund shareholders.”

New Low in Fund Charges

The Vanguard Group says its recently introduced Admiral Funds will feature much lower operating expenses than competing bond portfolios.

Operating expenses include the management fee along with charges for custodian, legal, accounting and various other services. Collectively, they’re expressed in a standard measure known as the expense ratio.

For example, a 0.8% ratio means a fund charges $8 in combined expenses for every $1,000 a person invests. The ratio excludes sales charges or loads, if any, but includes marketing fees. Expenses reduce your investment return.

In general, stock funds are more expensive than bond funds, and international portfolios are more costly than domestic. Here’s how the Admiral Funds’ projected expense ratios compare to industry averages.

Fund Category Avg. Expense Ratio Vanguard Admiral Funds 0.15% Single-State Muni Bond 0.61% Treasury Bond 0.70% National Municipal Bond 0.79% High-Quality Corp. Bond 0.83% Government Bond 1.11% Equity-Income Stock 1.15% High Yield Corp. Bond 1.19% Balanced 1.22% Growth & Income Stock 1.23% Growth Stock 1.31% Small-Company Stock 1.41% World Bond 1.56% Aggressive-Growth Stock 1.68% International Stock 1.70% Precious Metals Stock 1.73% Global Stock 1.76% Natural Resources Stock 1.81%

Source: Morningstar Mutual Funds, Chicago